Capital requirements might be doubled for investment firms

According to new research from KPMG, nearly half of all investment firms could be forced to double their capital requirements.

The new study looked at responses and mandatory Internal Capital Adequacy Assessment Process (ICAAP) documents from 32 firms, finding that insurance mitigation and diversification are often used to reduce capital requirements.

Shock events

The Big 4 firms' 'Right from the Start' report revealed that in 2015, 42% of firms used either mitigation or diversification methods, and 25% used both. The first pays out if there is a major shock to the business, and the latter mixes a wide variety of investments across a portfolio to lessen the effect of any shock events.

These techniques reduced capital requirements by an average of 56%; however, the Financial Conduct Authority (FCA) has changed the way that insurance mitigation can be applied.

The report also points out that the Basel framework firms have been using the wrong method when calculating diversification benefits because causation instead of correlation has been cited.

Bad news

David Yim, KPMG investment management partner, said: "Being forced to hold higher levels of capital is bad news now more than ever for investment firms. Firms could be missing out on a huge market opportunity in front of them."

"Current practice is exposing firms to a real risk of being compelled to seek substantially more capital. Firms must understand how best to deliver to the regulator’s demands. More must be done to properly link firms’ risk management processes and metrics with business strategy," he explained.

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